What's Wrong with Tariffs?

There has been a recent rash of books which concern development policies in the third world over the past 50, or so, years. An example is "Bad Samaritans" by Ha-Joon Chang which supports protective tariffs for countries trying to establish their own domestic industries without having to worry about the competition from already dominant foreign firms. There have been others by Joseph Stiglitz, William Easterly, and Paul Collier.

This is part of a small, but increasingly vocal, heterodox movement which disagrees with the conventional wisdom that "free trade" is the correct solution to all international economic issues. I'm not interested in rehashing the arguments, other than to point out that the "protectionists" can point to some rather successful examples that illustrate their thesis. In this book, it is the author's home country of South Korea.

I'd like to examine another idea, that of using tariffs in developed countries as a way to compensate for existing wealth and tax inequalities. Suppose a developed country imposed a tariff on items which it doesn't produce locally, or produces in such small quantities that there is, essentially, no domestic industry. A good example would be consumer electronics or shoes in the US.

Suppose the government imposed a tariff on these items and then adjusted the income tax rate so that the average consumer came out with as much spending power as before. You pay an extra $100 in the retail price of your next TV, but your income tax is reduced by $100.

Arguments that the tariff would limit trade don't hold up, the (average) consumer has just as much money to spend as before. There should be no change in demand and there is no domestic market which is being given "unfair" protection in violation of the current free trade agreements. If everything is a wash, then why do it?

Notice that I said that the average consumer would come out the same, but the distribution will not be uniform. For example those at the bottom, who don't buy many consumer electronic items, will see a net increase in after tax income, while those at the top who buy lots of expensive gadgets will end up paying more in taxes. The result is a (slight) shift in income toward the poor. If, there is also some slight decrease in purchases of imports, this is also a benefit, since the balance of payments is much too lopsided these days.

I see this as a mechanism similar to the VAT. By pushing the tax onto consumption rather than income, it hits the wealthy more and defuses the objections of the conservatives who always complain about taxes being too high. What they mean is that the income tax is too high, but a VAT or tariff hits everyone equally, that is everyone pays the same rate, but the amount you pay depends upon your own behavior.

Even in the current climate where tariffs are frowned upon (or "illegal" according to the WTO) I could see a country making a valid claim for this mechanism, since the tariff is only a variant tax collection mechanism and not being used to protect local interests.

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Copyright © 2008 Robert D Feinman
Feel free to use the ideas, but the words are mine.